IRA Assets And Alternative Investments

February 26 2009| Filed Under » , , , ,
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Step aside, stocks and bonds - alternative investments are becoming an increasingly popular choice for those seeking to invest their retirement plan assets. These non-traditional investment vehicles range from the familiar - for example, limited partnership units - to the not so common, such as real estate investments. Regardless of the form these investments take, however, certain rules and regulations remain constant. For IRAs, failure to adhere strictly to these rules and regulations could result in loss of tax-deferred status for the IRA assets. Read on for a high-level overview of these rules, as well as some other points you should keep in mind when considering alternative forms of investment for your IRA assets.

What Is It?
Broadly speaking, an alternative investment is any investment other than the traditional investments such as publicly-traded stocks, bonds and mutual funds. The actual definition of alternative investment varies among financial institutions and investors, but it generally includes hedge funds, real estate, venture capital and derivatives. Many financial institutions that facilitate these investments conduct frequent reviews and analyses to determine whether they need to increase their list of alternative investment offerings. Therefore, if your financial institution does not allow the type of investment in which you are interested today, you should check back at a later date because things may change.

Gauging the Risk

Limiting Losses
Investment professionals typically limit their recommendations for alternative investments to accredited investors because these investors tend to have a higher risk tolerance. Even so, professionals usually recommend that investments in such assets be limited to no more than 10% of the investor's portfolio. This restriction helps to ensure that any losses are limited, while allowing the investor to share in any profits.

Avoiding Prohibited Transactions
This new investing trend has many people looking to invest their retirement assets in their own property, or property in which they have shared ownership. However, the old adage "you can't have your cake and eat it too" rings true in most cases involving non-traditional investments for IRAs and other retirement plans, because such practices could result in a prohibited transaction taking place. As such, investors and those who advise them must exercise caution to ensure compliance with applicable rules.

A prohibited transaction occurs when the IRA engages in certain transactions with the IRA owner or another disqualified person. For these purposes, a disqualified person includes the following:

  • the IRA owner
  • the IRA owner\'s spouse
  • the IRA owner\'s ancestor
  • the IRA owner\'s lineal descendant
  • any spouse of the IRA owner\'s lineal descendant(s)
  • investment advisors
  • the IRA custodian or trustee
  • certain entities in which the IRA owner owns at least 50% interest, such as a corporation, partnership or trust
Not all transactions that occur between a disqualified person and the IRA will result in a prohibited transaction. A list is provided in the tax code to ensure that taxpayers are aware of what constitutes a prohibited transaction. The tax code states that a disqualified person is considered to have engaged in a prohibited transaction with an IRA if any of the following occurs:

  • a sale or exchange, or leasing, of any property occurs between the IRA and a disqualified person;
  • there is lending of money or other extension of credit between the IRA and a disqualified person;
  • there is a furnishing of goods, services or facilities between the IRA and a disqualified person;
  • the assets are transferred to - or used by or for the benefit of - a disqualified person;
  • any action by a disqualified person who is a fiduciary whereby the fiduciary deals with the income or assets of the IRA in his or her own interests or for his or her own account; or
  • receipt of any consideration for his or her own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.
If your IRA assets are engaged in a prohibited transaction, it could result in the IRA being treated as a distribution to you, the IRA owner, as of the first day of the year in which the prohibited transaction occurs. Let's look at an example.

Example
Jim and Jane Savvy want to invest in a timeshare in Jamaica. Their research shows that they could not only make a profit from renting the property to others, but also save on vacation expenses by using the property instead of staying in hotels when they vacation in Jamaica. Jim decides to use $100,000 of his $1 million IRA balance to invest in the timeshare. Jim is a disqualified person because he owns the IRA. Furthermore, because the timeshare is intended for Jim\'s personal use, the use of assets from his IRA to invest in the timeshare is considered a prohibited transaction.
As a result of this transaction, the entire value of Jim\'s IRA as of January 1 of this year is treated as having been distributed to Jim. If the property had not been used by a disqualified person (Jim), the investment would very likely have been acceptable for Jim\'s IRA.

In some cases, the penalty is limited to the amount invested in the prohibited transaction. These include investing the IRA assets in life insurance and collectibles. For this purpose, collectibles include artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages and certain other tangible personal property.*

*Note: There are exceptions to this rule. Your IRA can invest in one, one-half, one-quarter or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium and platinum bullion (see IRS Publication 590 at the IRS website).

Complex Rules
It can be a complicated process to determine whether an investment could result in a prohibited transaction. Figuring this out usually requires the assistance of a competent tax or ERISA attorney. In fact, there are some instances in which exceptions have been granted by the Department of Labor (DOL): these are referred to as "prohibited transaction class exemptions" (PTCE). On the other hand, there have been cases in which the DOL determined that some investments were prohibited transactions, when tax professionals thought otherwise. To ensure that a proper determination is made regarding such investments, investors should seek the assistance of a tax professional with experience in the field.

Proceed at Your Own Risk
Financial institutions that offer alternative investments typically implement policies and procedures to shield themselves from liability. For instance, an investor may be required to sign what is known as an "indemnification and hold harmless agreement", agreeing that the financial institution bears no responsibility for any losses incurred by the investor. The procedure may also require a certification from the investor that he or she has consulted with legal counsel regarding the investments, and that he or she is not a disqualified person. Consequently, any losses that occur as a result of these alternative investments must be fully borne by your IRA.

Conclusion
So, are you one of those investors who is no longer satisfied with waiting for returns on traditional investments such as publicly-traded stocks, bonds and mutual funds? If you want to explore the possibility of putting your retirement funds in alternative investments, then thoroughly researching these investments should be at the top of your investing "to-do" list. In addition to researching which financial institutions allow these investments, you should also get professional assistance to ensure that the investments do not result in penalties and loss of tax-deferred status for the IRA assets.

To learn more, see The Pros And Cons Of Alternative Investments, Consequences Suffered By Non-Conforming IRAs and Retirement Planning Basics.

Individual Retirement Accounts Feature Click Here
by

Denise Appleby

Denise Appleby
Denise Appleby is founder and owner of Appleby Retirement Consulting,which provides technical consultation, content, coaching, writing, editing and training services on related topics.


With more than 14 years of experience in the IRA and defined-contribution plans fields, Appleby has held several senior retirement-plan related positions with Pershing LLC, which included vice president of plans products and services, retirement plans manager, trainer, training manager, compliance consultant, technical help desk manager and writer.
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